Accounting Truths about Reserves

By Marvin Henry,2014-04-04 11:29
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Accounting Truths about Reserves

    Accounting Truths about


    What Do You Really Know???

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    Two Truths and One “Fib”

    By Gayle L. Cagianut, CPA

    Cagianut & Company, CPAs


    Two Truths and One “Fib”

    1. Replacement Fund is another name for


    2. The AICPA (American Institute of CPAs) gives

    CPAs the option of using the term Reserves.

    3. The Fund for Future Major Repairs and

    Replacements is an accepted name for


Discussion Notes:

#2 is the “fib”. CPAs have to use the term Replacement Fund or Fund for Major

    Repairs and Replacements in the audit report.

    The AICPA recommends fund accounting for Associations. They feel that this presents information that is most relevant for the Board and for homeowners. Industry standard (nationwide) is to have replacement fund activity segregated from operating fund activity. This includes having a separate fund balance on the financial statements and reconciling cash with the income and expenses charged to that fund.

    Two Truths and One “Fib”


    1. AICPA requires that the financial statements

    record the budgeted reserve allocations as

    income to the replacement fund no matter what

    cash gets transferred.

    2. If the Association does not fund reserves in

    accordance with their budget, but they plan to

    repay the money at some point, an amount is

    setup as “Due Between Funds”.

    3. The CPA determines whether the Association will

    repay the monies owed between the funds.

Discussion Notes:

    #3 is the fib. That determination really should be made by the Board of Directors and be documented in the Board meeting minutes. Washington law now has a provision requiring repayment for condominiums unless there it would impose

    an “unreasonable burden” on the owners.

    For GAAP (generally accepted accounting principles) purposes, CPAs must record the transfer from operating fund to the replacement fund based on what was budgeted to be transferred, not the actual cash transfer.


    Two Truths and One “Fib”

    1. AICPA is silent with regards to the requirement to

    include reserve study data in an audit.

    2. Reserve study is included in the audit as

    “Required Unaudited Supplementary Information”

    3. Breakdown of the replacement fund balance by

    component is not required by AICPA.

Discussion Notes:

#1 is false. The reserve study information is “required unaudited supplemental

    information”. Certain information from the study must be included in the audit or the audit must be amended to state that it is missing, and why it is missing.

    The required information to include in the audit is as follows:

    ; When the study was performed and whether it was performed by the

    Board or a professional.

     Components (however, how much detail is left to the Board). ;

    ; Current or future replacement costs

    ; Interest and inflation rates, if any

    ; Remaining useful lives

    In addition, the CPA must disclose if the Association does not fund in accordance with its reserve study.

    Two Truths and One “Fib”


    1. It is somewhat subjective as to what is an

    operating expense versus a reserve expense.

    2. Board meeting minutes must indicate whether it

    is an operating or reserve expense.

    3. The reserve study and governing documents are

    the best tools for determining a reserve expense.

Discussion Notes:

    #2 is the fib. However, I strongly recommend that approval of all reserve expenses be recorded in the Board meeting minutes. This is an important internal control and it provides an audit trail at the end of the year.

    What are operating expenses versus reserves expenses? The reason it is subjective is for a few reasons. 1) What one association chooses to fund in reserves might be taken care of in the operating fund in another association. For example, one association builds up the replacement fund to paint every 7 years. thAnother association paints 1/7 of its buildings every year as an operating

    expense. 2) An expense that extends the life of the component may be considered to be a replacement fund expense in some instances. For example, simple roof repairs may be operating expenses; however, fixing a section of roof may allow to put off replacing the whole roof for an addition 3 years, so they will use replacement fund monies. 3) If the issue is a health & safety, water intrusion or other required repair, many attorneys feel that it is appropriate to spend replacement fund monies, even when the component is not in the reserve study.


    Two Truths and One “Fib”

    1. The IRS does not consider painting as a

    legitimate reserve component. It is considered to

    be “noncapital” or an operating expense.

    2. Painting should not be included in the reserve

    study if the Association wants to maximize their

    tax savings.

    3. Tax savings can still be realized with painting in

    the reserve study; however, there should be a

    replacement fund on the books and a reserve

    study that agrees with the budgeted allocations.

Discussion Notes:

    #2 is the fib. Anything the Board wants can, and should, be included in the reserve study. This is a tool to be used for the Board. The CPA can make the appropriate, necessary adjustments for tax purposes.

    Sample Balance Sheet with Due Between Funds


    Here is the amount shown as being due between funds. The amount in the operating fund is a credit as the money is owed from the operating fund and is due to the replacement fund.

Due Between Funds usually occur because:

    ; The budgeted amount was not transferred as planned by year end

    ; Expenses of one fund were paid by the other fund.

    ; There was money actually borrowed from one fund and will be repaid,

    e.g. sometimes for the insurance premium or when funds are short.

    Sample Fund Balance Income Statement


    This is the budgeted reserve allocation. Thus, the total assessments were $525,813, and of that amount $75,012 was budgeted to go to the replacement fund.


    Sample Required Unaudited Supplemental Information in Audit Report


Note: Percent Funded Optional Disclosure

    Sample Wording in Audit Report

    If there was no reserve study the last two lines would be omitted and it would state “That information has not been presented.”

    Approval of Reserve Expenses Q&A



    During our annual audit, our accountant requested that all reserve expenses be approved in the board meeting minutes. Why? Is this required? This seems like a lot of work and we have a reserve study which has our reserve components listed. Can you explain this recommendation?


    An accountant is charged with the duty of ensuring that the financial statements are properly stated. The auditor also has a responsibility to plan and perform the audit to obtain reasonable assurance that the financial statements are free of material misstatement, whether caused by error or fraud. This requires the auditor to use judgment in determining the procedures they will use.

    Each auditor will have different ideas as to what procedures are necessary to fulfill these requirements. There is little guidance in the CPA industry with regards to homeowner association audits. The American Institute of CPAs does publish periodic “Audit Risk Alerts” and this question was addressed in the 2000/01 edition as follows:

“What might you (the CPA) consider when reviewing the minutes of your CIRA client?”

    Replacement fund transactions. Minutes highlight replacement fund transactions, including replacement expenditures and other additions or subtractions to or from the fund. In addition, minutes reveal the approval of any replacement fund expenditures, accompanied by specific details related to the expenditure.

    On a related subject of internal control, the 1999/2000 edition stated the following: “…more than one board member should review and indicate approvals of requests for all major work to be performed by contractors to help eliminate the opportunity for noncompetitive bidding.”

So is it REQUIRED to be in the minutes, from an auditor’s standpoint? No. It depends on

    what the individual accountant feels enhances their ability to determine the correctness of the financial statements and reduces the chance of fraud.

    I have four additional reasons why I strongly advise that all reserve expenditures be approved in the board meeting minutes.

    1. Washington law makes the point in various sections that reserve monies are

    “sacred”. Such items as requiring two board signers, defining reserve accounts,

    requiring disclosure of reserve components and requiring payback of reserve

    monies in a timely manner emphasize the point that reserve monies are to be

    used as intended and not for operating type of expenditures. Because

    Washington law specifically places the responsibility for reserve accounts on

    the board of directors, I feel that the board needs to document their approval

    of use of monies out of the reserve (replacement) fund.

    2. Reserve expenses are still not clearly defined. There is much judgment

    involved to determine when it is a reserve expense rather than an operating

    expense. What one board feels is a roof repair extending the life of the roof


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